A Greenspan or Bernanke Put?

The recent stock market movements have rekindled talk of the "Greenspan Put," but there are questions about whether such a put has ever existed:

Central Bankers Won't Jettison 'Greenspan Put', by Matthew Lynn, Bloomberg: As global markets wobbled nervously last week, one thought appeared uppermost in the minds of many investors: If this gets nasty, then Alan Greenspan isn't going to be standing by to bail us out this time.

The ''Greenspan put'' -- the helpful way the former Federal Reserve chairman responded to big declines in the stock market by delivering a cut in interest rates -- is assumed to have left the building along with the man himself.

The current ruling clique of central bankers -- Ben Bernanke at the Fed, Jean-Claude Trichet at the European Central Bank, and Mervyn King at the Bank of England -- is thought to be made of sterner stuff. Anti-inflationary discipline is the new mantra. If stock markets collapse, and lots of overpaid hedge-fund managers get burned, then so what? It's not the job of central bankers to ensure rising equity prices.

But hold on. Who says they wouldn't do much the same as Greenspan if faced with a similar set of circumstances? If there was any evidence that the steady increases in global interest rates over the past year were going to create a sustained bear market, central banks would certainly act.

What else are they meant to do? Sit idly by while the global economy slips into recession? The truth is, the ''Greenspan put'' will outlive its creator. ...

It isn't evidence of "a sustained bear market" that would cause the fed to act, the Fed would only act if it feared slowing economic activity generally. To the extent that stock prices and the state of the economy are correlated, and the short-run correlation is not all that large, it may appear that the Fed is moving to prop up asset values, but that is only a by-product of the Fed's attempt to stimulate activity more broadly, policy is not directed at the stock market itself. St. Louis Fed president William Poole explains:

Much of the time, I believe, stock price changes do reflect reasoned information about future earnings growth. Thus, my first instinct is to interpret stock market changes as reflecting probable changes in future earnings, which in turn may reflect emerging trends in the economy. ... This information is obviously relevant for monetary policy. Unfortunately, stock prices have a significant overlay of noise-uninformative, short-run fluctuations-that makes it highly problematic to put much weight on the stock market in reaching judgments about the appropriate course of monetary policy. Moreover, it does seem that some changes in market prices reflect an irrational component. I do not believe that anyone will ever find simple, straight-forward measures of the irrational component, or regularities that will permit us to determine reliably that the stock market is significantly over- or under-valued.

So, again, the Fed does not focus on asset values per se, they are only important to the extent they signal broader changes in the economy.

Finally, it is commonly assumed that a Greenspan put existed, but did it? Let me turn it over to Brad DeLong who has looked into this question:

A "Greenspan Put"?, by Brad DeLong: Four years ago Barry Eichengreen and I wondered whether the "Greenspan Put" had been a powerful force pushing up lending to high-risk countries in the mid-1990s and pushing up stock prices during the dot-com bubble. But we found a problem: we couldn't find significant evidence that this was the case--indeed, we couldn't find that many mentions of the "Greenspan Put" in the financial press or the financial newsletters in the first place. If it was part of the Zeitgeist, it wasn't in any place very visible to us.

The idea of an important "Greenspan Put" lost plausibility as the Federal Reserve did not take steps to lower interest rates as the NASDAQ fell, but instead waited until it saw signs of slackening investment growth. How could anyone in the aftermath of the NASDAQ crash could speak ... of the Fed as providing "free insurance for aggressive risk-taking"?

[There is confusion]... between the effects of (i) good, stabilizing monetary policy ..., and (ii) the "Greenspan Put" proper...

Comments

[groucho]

"it may appear that the Fed is moving to prop up asset values, but that is only a by-product of the Fed's attempt to stimulate activity more broadly, policy is not directed at the stock market itself."

Hmmmmm....serial bubble blowing in an ASSET economy with a FED that studies "wealth effects" of said asset bubbles.... And they're not preoccupied with putting a floor under said assets?
As soon as Bernanke feels he has conquered his "inflation expectation" goal he will be cutting FFR(THE "PUT")

In the mean time.....over in China HUD's Jackson is being snubbed by China on China's duty to help with the housing PUT by purchasing more MBS.

What kind of quid pro quo can Paulson come up with to convince China to jump in front of that train?

[oops]

i'm not sure what the falling nasdaq has to do with disproving the "greenspan put" theory because it always seemed like if there was anything greenspan was clear about it was irrational exuberance in the stock market.

i'm not a fan of the "put" theory because the most often sited example is the failure of the hedge fund LTCM and the (if not mistaken) 75bp cut that allowed it to sell its assets.

good account of the story in book "when genius failed" says that the cut came when the ny fed chair met with investment bankers to see what needed to be done to prevent a liquidity crisis.

the cut that followed put some arbitrage back into the convergence trade that everyone had on at the time and the markets waited out the storm. this does point to just waht de long was talking about- sound monetary policy (or at least what the fed considered sound monetary policy).

[Winslow R.]

If I speak with 'authority' forgive me as I have no inside knowledge of what Paul, Ben or Alan have done in the past.

William Poole, Brad and Mark may have no knowledge either, but I will allow them to ask for your forgiveness.

We'd all agree financial flows are manipulated by people. The more powerful the people the more powerful the manipulations. I'd identify Ben and Paul as being two of the most powerful (with regards to financial flows) in the U.S. and having contact with the most powerful people in other countries and therefore the ability to influence their actions.

What could be explored further is why sometimes the stock market is weakly correlated to the state of the economy yet other times more strongly. I find this to be a time of strong correlation.

[James Killus]

This looks like another example of the "moral hazard" theory, where protections against losses make individual decisions more risk prone.

While the theory is attractive, at least intuitively, I tend to think that people focus (at least) too narrowly on a given example of insurance against loss and do not cast the net widely enough. Do money managers really fear loss so greatly when it is other people's money they are risking, or is it more a matter of staying close to the herd, so that only the slowest members get thrown to the wolves?

Do people only build houses on the sides of volcanoes when they have home owners insurance?

And while Greenspan (and other central bankers) may have acted to preserve the banking system generally, did those actions really make bankers more prone to risky behavior than was the case in, say, August of 1929?

[wimpie]

What kind of quid pro quo can Paulson come up with to convince China to jump in front of that train?

groucho, maybe an even trade; american toxic waste(subprime laced cdo's,etc..) for chinese toxic waste(melamine pet food, lead painted toys, etc....)

[Bruce Wilder]

I wonder if the so-called Greenspan put was not just Greenspan avoiding a credit crunch, something Bernanke does not have the option of doing.

Mark Kleiman offers a useful anecdote pointing to the credit crunch.

Having a perfect credit history, a decent income, and a fairly solid balance sheet, I have been a beneficiary of one of the stranger stunts performed by the credit-card industry: the offer of very-low-interest, or sometimes even zero-interest, loans.

These are usually for a few months at a time, after which the interest rate reverts to the normal (i.e., usurious) level. I guess the gamble is that there will be enough customers who get sucked into overspending by the offer of cheap credit and then have to pay the Shylock rates when the teaser rate runs out, or who don't understand that you can't play this game with a card you actually use to buy things with, to make up for people like me, who cheerfully take the arbitrage ($20,000 borrowed at 0% for six months and put into a money-market fund is like a gift of $400) and then pay in full the day before the rate goes up. And pretty reliably, a few weeks after paying off one cheap loan, I get checks in the mail from the same issuer offering me another cheap loan.

Even banks I've been doing this to for years never seem to catch on, and cheerfully keep increasing my credit limits, lending me lots of money on just my signature at rates way below what they'd charge on a mortgage or home-equity line of credit.

Until now. In the past month, I've gotten letters from two banks, one shutting down my account entirely (just after I paid off the introductory-rate loan) and another cutting my line of credit in half. The notices explain that they've checked my credit-bureau reports and found high ratios of debt to account limits, which is correct but no more correct now than it has been often in the past.

Now, these seem to me like very reasonable business decisions. But they would have been just as reasonable last year, or five years ago. I have no reason to think that the credit-card issuers are getting smarter.More likely, they're getting more nervous about the ability of even prosperous folks to pay off lots of debt, and they're reducing their exposure accordingly.

Though I'll miss their generosity, I wasn't dependent on it. But I did treat money available on those accounts as if it were cash in the bank for cash-flow-planning purposes, and I'm sure I wsan't alone. If the cutbacks on credit-card lines of credit is general, it amounts to a reduction in the effective money supply. (I don't know enough macro to know whether there's some measure of the money supply that counts those lines of credit; if so, it must be M4.5, or thereabouts.)

[Winslow R.]

Before this link disappears...

President Bush struck a reassuring tone Wednesday about recent turbulence on Wall Street, saying he believes the markets will work their way through the turmoil safely and achieve a "soft landing."

http://biz.yahoo.com/ap/070808/bush_economy.html?.v=19

Sounds like a Bush Put to me :)